On that Dour Reaction to ‘Goldilocks’ Q3 GDP

US Q3 GDP data published Thursday and, as many expected, growth quickened: The 4.9% annualized growth rate marked the fastest pace since Q4 2021—or Q3 2014, if you prefer prepandemic figures to avoid reopening skew.^[i] Some argue this is “too hot,” spurring more inflation and rate hikes. Others warn GDP’s “summer surge” will soon cool into a winter chill. Neither are happy. But a look under the hood shows GDP’s main private-sector drivers growing fine, undercutting both fears.

Those arguing the overheating case should find some solace beneath the headline GDP figure. While consumer spending’s 4.0% annualized growth was strong, that isn’t particularly unusual. Q1’s 3.8% was similarly robust, yet inflation has cooled all year.^[ii] Furthermore, Q3’s inflation uptick came alongside slowing core prices. Remember: Inflation is about money supply and that is falling slightly.

But there is more. Namely, the headline rate overstates actual growth trends. The main difference between Q1 and Q3 was inventory change, a frequent skew in recent quarters. For example, Q2 2022’s much-ballyhooed -0.6% annualized headline GDP dip—the second straight—was entirely driven by a -2.1 percentage point (ppt) inventory detraction from headline growth.^[iii] Similarly, in Q1, inventories detracted -2.2 ppt, whereas they added 1.3 last quarter. (Q2’s inventory change was zero, so it had no effect.) In Q3’s case, growth excluding inventory change was 3.6% annualized, slower than Q1’s 4.4%.

Why strip them out? Because it isn’t clear from the report—and never has been—whether inventory gains are because of overstocking or businesses anticipating further demand growth. It could be interpreted positively or negatively. Based on recent purchasing managers’ surveys, though, businesses’ current inventory levels don’t appear excessive, so we guess we would side with the positive camp now.

As for those thinking Q3’s GDP report masks underlying weakness—from flat business investment, but also dwindling savings rates and personal income after inflation—these fears are long-running and haven’t borne out. Yes, business investment is often a swing factor for growth, but it also frequently dips negative without consequence. One quarter’s -0.1% annualized decline after seven straight quarters of growth doesn’t make a trend.[iv]

Meanwhile, household finances are in much better shape than many realize, supporting further consumer spending. Coverage suggests Q3 will be consumers’ last hurrah amid inflation, rising rates and pandemic savings’ depletion. But those alleged headwinds have featured prominently for more than a year—while consumption has chugged along. With disposable personal incomes rising faster than inflation since January, debt service near record lows—and delinquencies, too—consumers don’t seem tapped out. Look, we expect GDP and consumption to cool some from here. But the fear of it flipping into recession seems like a stretch to us.

The funny thing about the reaction to Thursday’s report is this: While most people pondered whether the data were too hot or too cold, it is pretty easy to see them as “just right.” In March 1992, Salomon Brothers analyst David Shulman dubbed the US economy “Goldilocks” when it grew 4% annualized with 3.2% inflation. That term became baked in the financial lexicon for nearly a decade, before the 2000 – 2002 Tech bust hit. The GDP report showed pretty much exactly that! But we didn’t see too many references to the just-right porridge. Now, no economic data tell you exactly what is ahead—they are backward looking. But the dour reaction shows the Pessimism of Disbelief is alive and well. All the easier for reality to beat expectations, in our view.